Which factors will drive Indian equity markets now? Investor Ruchir Sharma explains

Prominent investor and author Ruchir Sharma believes that the domestic equity market is on an interesting journey where classic models seem less relevant due to a mix of fundamental strengths and market-specific dynamics. In a session at BT India@100, the chairman of Rockefeller International on August 20 said that domestic factors are largely driving the trend, powered by robust financialisation and increased local investment.

His comments come at a time when the benchmark equity indices are hovering at their record-high levels. Recently, the BSE Sensex and NSE Nifty scaled all-time highs of 82,129.49 and 25,078.30, respectively, on August 1, 2024. On a year-to-date basis, these indices have rallied more than 10% till date.

Sharma said that one factor contributing to this rally is the significant financialisation of the economy. Indian stock markets have witnessed substantial inflows from domestic investors. He also added that earnings growth is another fundamental factor supporting the Indian equity market. Data showed that domestic institutional investors have bought shares worth nearly Rs 3 lakh crore since January 2024. On the other hand, the net investment of foreign institutional investors (FIIs) stood at just Rs 13,800 crore during the same period.

Sharma pointed out that, unlike a true bubble scenario where prices soar despite deteriorating fundamentals, Indian corporates have shown robust earnings growth. This has provided a foundation for the soaring market valuations, driven by actual wealth creation.

“The classic models aren’t working for India as of now. The domestic flow of money and the financialisation trend have taken momentum. India is one of the markets in the world today which is more expensive than the United States in terms of valuations. It is functioning on its dynamics. The good thing is that it’s so far been broadly supported, at least by fundamentals. A true bubble is one where the fundamentals are deteriorating, but the prices are going up. In India’s case, there has been earnings growth in the stock market, so it’s been backed up by earnings growth,” Sharma said adding the country’s macroeconomic management has been relatively stable, which adds to investor confidence.

He added that the diversity and depth of Indian companies provide another layer of stability and growth potential, distinguishing it from other emerging markets, which are often concentrated in specific sectors like technology or commodities.

Sharma thinks that any shift in global capital flows is a major driver in the near future. With the US stock market heavily overvalued and the American economy running substantial deficits, there is likely to be a reallocation of capital towards emerging markets, of which India will be a significant beneficiary.

“The US economy is about 26% of the global economy and the US stock market is more than 50% of the global stock market value and according to the MSCI is close to 70%. So, 50% to 70% of your capital is allocated to America, and that has gone up dramatically over the last 10 to 15 years. That's bound to break. The dollar is bound to weaken and the capital flows are likely to come back to emerging markets, and India will be a beneficiary,” he said.

Despite the market’s strong performance, Sharma advised caution. He said any signs of declining earnings growth or deterioration in fundamentals could change the market dynamics. He stresses the importance of diversifying investments across multiple regions, even though India remains attractive due to its market depth and economic potential.